Why Wall Street Is and Always Will Be a Sales Organization - Part 2
Wall Street is a sales organization. Last time we saw how the wire houses on Wall Street have changed their way of doing business with clients so that it appears they are on the clients' side. Before we continue our discussion, let's be clear about something.
There are individuals who work for Wall Street firms whose main focus is gathering assets - as much as possible - to maximize their personal income. On the other hand, their are some who try to do their best for their clients. I know some. The important point here is that those who try to do the best possible job for their clients do so in spite of the firms for which they work. The Wall Street firms don't really care either way. They all claim they do, of course. They would like you to believe that they put your interests first, but their manner of doing business doesn't support their claims. The creation of the new "advisory" model, which we began to talk about last time, demonstrates this point.
The institution of a new "advisory" model, where the advisor no longer generates revenue by generating commissions supposedly establishes a relationship between client and Wall Street firms that benefits the client much more than the old model. But this appearance isn't really representative of the underlying reality.
The first thing to remember is that the new model was pushed and caught on at time when stocks were in the greatest stock bull market in history. During this time, advisors who put most of their clients' money is stocks saw the values of their accounts rise. (Remember here that Wall Street always recommends that you have most, or at least a good portion of your money in stocks.) Since the advisors compensation was based primarily (although not exclusively) on a percentage of the assets they had brought into the firm, their compensation rose along with the value of the clients' accounts. Everyone was happy.
It seemed to all work so well until the great bull market that started in 1980 ended in 2001. As stocks stopped rising, stock accounts stopped making money. As a result, many clients stopped making money. Of course, advisors continued to make money, since they continued to collect fees based upon a percentage of the assets they brought into the firm. And if an advisor's income stalled because the client's account didn't grow, the advisor could simply go out and gather more assets. The client, on the other hand, was stuck.
What about the wire houses? Of course, they didn't stop making money. Let's look at how they make money with this new model. You'll see that, like the advisors, they continue to make money, and that they can increase their revenue by increasing their assets under management. But in addition to the fee they charge for assets under management, they have additional streams of revenue.
One way they made money even though the stock market was flat because of mutual funds and something called SAM - separate account management. The new financial "advisors" recommend that clients put their money in mutual funds, many of which "kicked back" fees in various ways to the wire houses. They also put clients' money into so-called "separate accounts" managed by professional money managers who are not necessarily directly employed by the wire houses. (Of course, some firms recommend their own mutual funds and money managers who are employees of the firm; but some do offer "outside" funds not owned by the firm and managers who aren't employees of the firm.)
These money managers take a client's money and establish an individual account in the client's name. As opposed to a mutual fund, where the client's money is pooled with other people's money, this account is an individual account, "separate" from other clients. Of course, the account isn't run in any sort of customized fashion In fact, the account you hold separately with a professional money manager under these sorts of arrangements are run excatly like the accounts other clients hold. So the "separate" idea isn't all that "individual" in the end.
As opposed to mutual funds, the separate account managers sometimes charge lower fees (sometimes not). But the wire houses still make out. In addition to any revenue-sharing arrangement they may or may not have, they demand that the separate account managers do their trading through the trading desks at the wire house.
Ah, interesting isn't it? It turns out the wire houses don't really give up all that commission revenue that was once generated by their old-fashoined brokers after all. They keep some of that and add revenue from fees. Nice - at least nice for them. As for the clients, now that markets have been essentially trading flat since 2000, combined with the down stock markets of the early 2000s and the catastrophe of 2008-2009, many account are flat or down over the last decade.
So we see how these firms continue to earn commissions, and have added a stream of revenue from fees as a percentage of the assets under management. But in addition to the fees charged for "assets under management," the wire houses also concocted new "products" for the clients whose assets they had "captured." The advisors are fed a steady stream of these products - ranging from "structured notes" to hedge funds of varying sorts (and many more "creative" products), all of which carry additional layers of fees, a share of which fees accrue to the wire houses.
Oh, and when I refer to "wire houses," you can include many other brokerage organizations. It's not just wire houses who promote this new model and generate these multiple streams of revenue. The wire houses are just the biggest (by far) of the Wall Street firms who employ battalions of "financial advisors" who are employees of the firms, which brings us to a final point.
Remember that when someone is an employee of a firm, their primary loyalty is - indeed must be - to the firm. Reiterating the point made above, if the advisor tries to do the best they can for the client, they have to do it in spite of the fact that they are employees of the firm. For example, some products that firms push on clients through their advisors are real dogs. And some advisors do their best to shelter their clients from the dogs. Others, unfortunately, don't.
This is just a quick overview of why Wall Street is a sales organization. So there's so much more I could say about this subject, but for now, just be aware of exactly what the objective is when you engage the services of a Wall Street firm: they want to sell you something. Put another way, it's not about the "advice," it's about the sales.
Of course, there are professional organizations that dispense investment and general financial advice. They're not Wall Street firms.
There are individuals who work for Wall Street firms whose main focus is gathering assets - as much as possible - to maximize their personal income. On the other hand, their are some who try to do their best for their clients. I know some. The important point here is that those who try to do the best possible job for their clients do so in spite of the firms for which they work. The Wall Street firms don't really care either way. They all claim they do, of course. They would like you to believe that they put your interests first, but their manner of doing business doesn't support their claims. The creation of the new "advisory" model, which we began to talk about last time, demonstrates this point.
The institution of a new "advisory" model, where the advisor no longer generates revenue by generating commissions supposedly establishes a relationship between client and Wall Street firms that benefits the client much more than the old model. But this appearance isn't really representative of the underlying reality.
The first thing to remember is that the new model was pushed and caught on at time when stocks were in the greatest stock bull market in history. During this time, advisors who put most of their clients' money is stocks saw the values of their accounts rise. (Remember here that Wall Street always recommends that you have most, or at least a good portion of your money in stocks.) Since the advisors compensation was based primarily (although not exclusively) on a percentage of the assets they had brought into the firm, their compensation rose along with the value of the clients' accounts. Everyone was happy.
It seemed to all work so well until the great bull market that started in 1980 ended in 2001. As stocks stopped rising, stock accounts stopped making money. As a result, many clients stopped making money. Of course, advisors continued to make money, since they continued to collect fees based upon a percentage of the assets they brought into the firm. And if an advisor's income stalled because the client's account didn't grow, the advisor could simply go out and gather more assets. The client, on the other hand, was stuck.
What about the wire houses? Of course, they didn't stop making money. Let's look at how they make money with this new model. You'll see that, like the advisors, they continue to make money, and that they can increase their revenue by increasing their assets under management. But in addition to the fee they charge for assets under management, they have additional streams of revenue.
One way they made money even though the stock market was flat because of mutual funds and something called SAM - separate account management. The new financial "advisors" recommend that clients put their money in mutual funds, many of which "kicked back" fees in various ways to the wire houses. They also put clients' money into so-called "separate accounts" managed by professional money managers who are not necessarily directly employed by the wire houses. (Of course, some firms recommend their own mutual funds and money managers who are employees of the firm; but some do offer "outside" funds not owned by the firm and managers who aren't employees of the firm.)
These money managers take a client's money and establish an individual account in the client's name. As opposed to a mutual fund, where the client's money is pooled with other people's money, this account is an individual account, "separate" from other clients. Of course, the account isn't run in any sort of customized fashion In fact, the account you hold separately with a professional money manager under these sorts of arrangements are run excatly like the accounts other clients hold. So the "separate" idea isn't all that "individual" in the end.
As opposed to mutual funds, the separate account managers sometimes charge lower fees (sometimes not). But the wire houses still make out. In addition to any revenue-sharing arrangement they may or may not have, they demand that the separate account managers do their trading through the trading desks at the wire house.
Ah, interesting isn't it? It turns out the wire houses don't really give up all that commission revenue that was once generated by their old-fashoined brokers after all. They keep some of that and add revenue from fees. Nice - at least nice for them. As for the clients, now that markets have been essentially trading flat since 2000, combined with the down stock markets of the early 2000s and the catastrophe of 2008-2009, many account are flat or down over the last decade.
So we see how these firms continue to earn commissions, and have added a stream of revenue from fees as a percentage of the assets under management. But in addition to the fees charged for "assets under management," the wire houses also concocted new "products" for the clients whose assets they had "captured." The advisors are fed a steady stream of these products - ranging from "structured notes" to hedge funds of varying sorts (and many more "creative" products), all of which carry additional layers of fees, a share of which fees accrue to the wire houses.
Oh, and when I refer to "wire houses," you can include many other brokerage organizations. It's not just wire houses who promote this new model and generate these multiple streams of revenue. The wire houses are just the biggest (by far) of the Wall Street firms who employ battalions of "financial advisors" who are employees of the firms, which brings us to a final point.
Remember that when someone is an employee of a firm, their primary loyalty is - indeed must be - to the firm. Reiterating the point made above, if the advisor tries to do the best they can for the client, they have to do it in spite of the fact that they are employees of the firm. For example, some products that firms push on clients through their advisors are real dogs. And some advisors do their best to shelter their clients from the dogs. Others, unfortunately, don't.
This is just a quick overview of why Wall Street is a sales organization. So there's so much more I could say about this subject, but for now, just be aware of exactly what the objective is when you engage the services of a Wall Street firm: they want to sell you something. Put another way, it's not about the "advice," it's about the sales.
Of course, there are professional organizations that dispense investment and general financial advice. They're not Wall Street firms.
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